India saw major foreign investment announcements last week. Google – $10 bn, Apple supplier Foxconn – $1bn, Pegatron, Qualcomm, Walmart etc., brought Make in India momentum in India. These announcements comes to more than $20 billion foreign investment for the financial year 2021 amid the COVID crisis.
Why India?
China has a closed investment policy, not permitting investments that can compete against its domestic players. Also with growing Sinophobia (Anti-Chinese sentiment), companies like Foxconn are moving away and choosing India as their preferred destination. India is their next go-to country with its large market size and open business environment.
The corporate tax cut is finally paying off. With an already low cost of labor than China, reduced taxes are making the investments attractive. Diversification of their investments, preferential tariffs are other reasons for FDI. More such investments are expected as India welcomed foreign direct investment in Social Networking amid a ban on Chinese apps. India achieved an 18% increase in FDI last year worth $73.4 billion.
In the light of the COVID crisis and negative GDP growth rate, -9.5% predicted by ICRA for 2021, these investments are a hope to make impetus effect to boost the economy. India benefits from FDI in a number of ways. Firstly, foreign investments for Indian innovative products make a source of capital resources, a better choice for consumers, and improved efficiencies. Secondly, it appreciates Indian currency. Thirdly, with increased production of goods or services, India’s GDP increases. It can be said to have spillover effects. India has a conventional foreign policy where it is mandatory for a few sectors for local procurement and local employment after the establishment of the firm. This provides business opportunities to MSMEs and employment opportunities to its people.
However, these foreign investments are no cakewalk this year with many amendments made in FDI policies. Firstly, changes in Double tax avoidance agreement (DTAA) rules to halt treaty shopping of foreign firms. Singapore was the top investor in India in the last two financial years with a whopping 30% toppling Mauritius who had 32% of India’s foreign investment in previous years. With a low taxation rate in Mauritius and Singapore, firms find a route to India through the establishment in these countries. With recent amendments in DTAA with these countries, India could gain potential investments directly rooted in India or may see a fall in investments this year.
Source: Researchgate
Secondly, Transfer Pricing in which multinational firms avoid taxation by reporting increased costs and hence decreased profits. For Example, Firm A has two entities in two countries, Entity X in country M with tax rate 10% and Entity Y in country N with tax rate 15%. Entity X sells tires to Entity Y – car manufacturing for higher cost than the market price as it will increase COGS of Entity Y(high tax country) and Sales revenue of Entity X(low tax country) reducing net tax. Recently the Central Board of Direct Taxes(CBDT) amended rules to include Arm’s length pricing with dispute resolution. Arm’s length pricing means the same price should be charged to unrelated and related parties.
In this backdrop, leveraging the present situation to increase foreign investment is the goal. However, focussing on conventional policies with incentives may not be the ideal strategy. Understanding how firms make foreign investment location decisions need to be taken into consideration.
As per Behavioural Economists, foreign investment decision making links to managers’ experience or perception of the business environment (Legal, Political, and Cultural) in the past, present, and future. The behaviour aspect over-weighs rational decisions (Real GDP, interest rate, Market Size), especially in uncertain conditions. Disrespect to patents, domestic preferential treatment, change in contract agreements is being seen in a negative light from foreign investors.
Hence, it is important for policymakers to the trade-off between liberal foreign investment policies and carrot stick policies (Carrot – Depreciation policy, tax concessions; Stick – Minimum export requirement, local content requirements). Crafting a balanced FDI policy for the success of firm and national development is the solution.
Government intervention can help firms with increased investment creating an environment for business establishment. For example Land acquisition, skilled labour, better transportation to the zone and consumer points etc.
But it can also reduce efficiencies in the market by blocking new entrants (can be a domestic firm) as former were given special treatment. Hence, drawing a line between neutral business-friendly initiatives and rent-seeking behaviour is way more crucial today.
Why care about Domestic Investments?
Well, with whopping foreign investments, India’s domestic investment concerns are often not in limelight. Domestic investments are way more important for numerous reasons. Firstly, dependency on foreign investment for India’s growth and technological colonization is a serious concern. Secondly, While we couldn’t participate much in the first three industrial revolutions, now is the opportunity for our economy to leap forward by grabbing the driver seat for the fourth industrial revolution. Thirdly, India could experience digital security threats with its data in foreign companies and also these firms could deny service and potentially pose as a threat during war-times. Fourthly, we all vividly remember the slowdown we experienced, which can be attributed to lack of domestic investment.
How is domestic investment scenario in India?
Increased interest rates, depreciating currency and dwindling corporate profits led to non-performing assets which led to banking stress and twin balance sheet problem. With this scenario, the majority of the flow of funds for new startups has been dependent on private sourcing. All these events led to decreased domestic investments.
Households contribute 60% of Indian savings and boost investments. But household savings plunged to 18 year low from 36% of GDP in 2007 to 30% in 2019. Decreasing household savings can be attributed to decreased financial and physical saving and growing inequalities.
To maintain growth, it seems best to tap foreign investment with decreased domestic savings. But can it be sustainable is the question. Mudra scheme, low-interest rate, Tax incentives, special economic zones can tap investment but have funds limitation and focus on MSME only.
Today to stand in front-end innovation for the digital sector, these incentives are welcome but not sufficient. Entrepreneurs and existing firms need strong investment sentiment, Startup culture, Motivation (a major factor for development in the Capability Approach by Amartya Sen), Handholding of firms, etc.
Domestic Vs Foreign investment preference has been debated for a long time. The need of the hour is a paradigm shift from conventional Interventionist policy to Enabler policy which will bring momentum in both investments. Focus on Human capital formation, Skill development, Ease of doing business, Good regulation policies, etc. can make a conducive environment for investments.
References
- Business Standard
- Harvard Paper – India’s Great Slowdown
- Reserach paper -Behavioural Economics and Empirical Decision on FDI
- Research paper – Behavioural Determinants on FDI
- theprint.in
- The Hindu
- CNBC
- BBC News
- Economic Times
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